AMERICAN ASSOCIATION OF WINE ECONOMISTS AAWE WORKING PAPER No. 147 Business THE BRITISH COLUMBIA WINE INDUSTRY: CAN IT COMPETE WITH THE BIG GUYS? Lee Cartier Feb 2014 www.wine-economics.org ISSN 2166-9112 The British Columbia Wine Industry: can it compete with the big guys? Lee Cartier1 Abstract In 1989, the Canada – United States Free Trade Agreement (FTA) was implemented and dramatically changed the course of the wine industry’s development in British Columbia (BC). The FTA forced the industry to make the transition from being highly protected, and inefficient, to a competitive market contender. Although considered initially to be a victim of the FTA, by 2010, the BC wine industry contributed $295.8 million to the BC economy, or 0.15% of provincial GDP, and provided 5,100 direct and indirect jobs; and is now considered by many to be a remarkable BC success story. This investigation traces the evolution of the industry from 2000 to 2010 by examining the structural changes that occurred in the industry’s value chain during that period. The study employs and industry cluster model to identify the relationships between the firms located in the Okanagan region. Results from the study show the growth in value added from all sectors of the value chain and identify several sources of the industry’s competitive advantage: extensive vertical integration, and a strong relationship to the tourism cluster. Conclusions are provided regarding the future challenges and opportunities facing the industry. 1 Okanagan School of Business, Okanagan College, 1000 KLO Road, Kelowna, British Columbia, V1P 1L2. E-mail: [email protected] Introduction The year 1989 was the ‘Big Bang’ for the BC wine industry. In that year, the Canada/US Free Trade Agreement (FTA) was signed and the industry began a massive industry transformation. In 1988, there were 3,400 acres of grapes in the Okanagan, producing 17,980 tons of grapes. One year later, in 1989, only 1,147 acres remained, producing 3,619 tons of high quality grapes. The ensuing industry transformation involved making the transition from a highly protected and inefficient producer of bulk ‘vin ordinaire’ to the production of premium and super-premium wines (Carew, 1998). In 1990, the BC Wine Act was enacted and the British Columbia Wine Institute (BCWI) was established. The Vintners Quality Alliance (BC VQA) was introduced and became the quality standard for BC wines1. The BC VQA program was selected as the vehicle that would rebrand BC wine as a high quality product. In order to meet BC VQA standards, the wine must be produced from 100% BC grapes. Wines that are a blend of BC grapes and imported grapes or bulk wine cannot be certified as BC VQA. With the introduction of BC VQA, everything changed. New methods of viticulture were needed to produce vinifera grapes in high latitudes; wineries had to develop new ways of producing exceptional wines made from high latitude grapes (cool climate oenology); new markets had to be developed to receive these higher priced wines. The pace of innovation during this period was remarkable, as new vineyards were planted, new wineries established and new wine varietals, such as ‘ice wine’, were developed and introduced. By 1999, over 3,000 acres had been replanted, bringing the total acreage to 4,184 acres, but producing only 11,284 tons of grapes. Not only did the varieties of grape plantings change from hybrid grapes to vinifera varieties, the reduced tonnage per acre, from 5.8 tons/acre to 2.7 tons/acre, reflected the reality that producing high quality wines put a ceiling on vineyard production. This change radically altered the cost structure of the industry. In order to be profitable, grape growers had to receive a much higher price for their grapes than prior to the FTA, and wineries had to receive a much higher price for their wines. In 2011, compared to other wine producing regions in North America, the BC wine industry is relatively small. Data produced for the British Columbia Wine Institute is reproduced in Table 1. 1 Table 1: BC Wine Industry Comparison2 British Columbia Ontario Washington State California 2011 2009 2010 2010 Acres 9,205 15,074 40,000 535,000 Number of Growers 705 500 350 4,600 Number of Wineries 229 146 655 3,364 The majority of the BC industry is located in the Okanagan region where 8,751 acres, or 88.7% are located3. The small size of the BC industry, and its producers, places it at a comparative disadvantage, in terms of economies of scale, relative to the US wine regions and Ontario. In spite of this, the strong growth in the number of new Okanagan firms entering the industry indicates their ability to achieve a competitive advantage. This research seeks to understand the nature of that competitive advantage. Methodology The economic analysis of the BC domestic wine industry value chain was developed entirely from secondary data; no primary research was conducted. The labour and value added calculations were prepared using a comprehensive economic model that was developed entirely from secondary data sources. The main secondary sources of information used to develop the model were provided by: • The BC Liquor Distribution Branch (BCLDB) • The BC Wine Institute (BCWI) • The BC Ministry of Agriculture and Land (BCMAL) • The BC Wine Authority (BCWA) • BC Stats • Statistics Canada (Stats Canada) A number of data tables were constructed from the data in these reports. • Grape growing employment • Grape growing cost structure • Wine sales (dollars) • Wine sales (liters) • Winery labour • Winery cost structure • Retail channel sales 2 An economic model of the wine industry was then developed from the data tables. This model provided the information required to complete the value chain analysis. The economic model covers the 10-year period from 2000 to 2010. Value Chain Analysis of the BC Wine industry Michael Porter’s industry cluster model was used as a framework to help understand the competitive environment facing BC wine firms. Porter’s “competitiveness diamond” identifies four determinates of competitive advantage: demand conditions, firm rivalry and strategy, related and support industries, and factor conditions (Porter, 1990). This model was selected as it helps to identify the relationships between the firms located in the Okanagan region: the interaction between competitors; their relationships with support and related industries; and how they interact with other firms in their associated value chains (Porter, 2003). The cluster approach to understand industry competitiveness and rural development has also been used in other regions (Delgado, Porter and Stern, 2010; Virkkala, 2007; Waites, 2000), and the wine industry in California (Porter, Ketels, Miller and Bryden, 2004). Industry clusters foster innovation (Arikan, 2009), aid in opportunity recognition (Ozgen, 2011), and lead to strong regional performance (Irshad, 2009). The BC wine industry is comprised of three sectors: 1. the BC grape growers who produce the grapes, 2. the BC wineries that manufacture the wine, and 3. the winery retail stores that sell the finished wine. The wine industry value chain is part of the region’s agricultural products cluster, and is represented in Figure 1. This figure shows the relationship between the value chain sectors and the four determinants of the agricultural products cluster. 3 Related and Supporting Industries - Grape production equipment - Bottles, closures, labels, etc. - Fertilizers, pesticides - Business services - Specialized winery equipment - Specialized publications GRAPE GROWERS WINERIES WINE RETAIL (9,205 Acres) (229 wineries) (7 Channels) - Seasonal Labour - Pacific Agri-foodResearch Centre - BC Government - Skilled labour - Commercial lenders & FCC distribution monopoly - Arable land, water, climate - Transportation Infrastructure - Tourism cluster pull- - BC Colleges & Universities - BC Wine Institute and BCWA through effects Factor Conditions Demand Conditions Figure 1: British Columbia Wine Industry Value Chain - 2010 Arable land in the Okanagan, suitable for grape for grape production, is limited. In order to increase the grape acreage, land currently producing other horticultural crops, such as apples and cherries, would need to be converted to grape production. This competition for land acts as a barrier for further industry growth. One alternative is to increase the grape yield/acre from existing grape acreage, but the quality imperatives imposed by the wine makers makes this option unlikely. However, interviews with leading grape growers indicate that they are experimenting with new viticulture techniques to increase yields, without sacrificing quality. More research and development (R&D) needs to be done in this area. Although there are 229 licensed grape wineries in BC, 18 of these wineries produce 92% of the domestic wine (see table 2), and all of these wineries are located in the Okanagan. The remaining 90 Okanagan wineries produce only 5% of the regions wine. Any bargaining power with suppliers rests with the 18 larger wineries, while individual small wineries have limited bargaining power with major suppliers or BC distribution channels. 4 The retail sector is a Provincial monopoly. The BC Liquor Distribution Branch (BCLDB) is the sole agent for the sale of all liquor products, both imported and domestic. The BCLDB sets the price for all wine sold in the province. This price is established by applying a standard markup of 123% to the price paid to the wineries. This markup constitutes a distribution cost for the wineries that choose to distribute through the BCLDB retail and wholesale outlets. The BCLDB also issues licenses to six groups of independent business operators to resell wine. These agents and licensees include the winery agency stores, cold wine and beer stores, BC VQA stores and restaurants4. Table 2: Okanagan Winery Groups Number of 2010 Sales % of Wineries (Cases) Market Major wineries 3 2,790,786 83 Medium Sized Estate Wineries 16 301,216 9 Small Sized Estate Wineries 89 168,346 5 Total Okanagan Based Wineries 108 3,260,348 97 Non-Okanagan Wineries 121 105,176 3 Total DomestiC Industry 229 3,365,524 100 All estate wineries, both large and small, operate their own wine shops.